Chapter 8 - Dividend policy Flashcards
What are the three main dividend policy theories?
- Dividend irrelevancy theory
- Residual dividend policy
- Dividend relevance
Who’s theory is Dividend irrelevancy theory
Modigliani and Miller’s
What is Dividend irrelevancy theory?
In a perfect market shareholders will be indifferent between receiving a dividend or a capital gain from a change in the share price.
What does Dividend irrelevancy theory assume?
That its a perfect market
What is a perfect market?
No taxation or transaction costs and perfect information
What is Residual dividend policy?
If there are positive NPV projects available then a company should always invest in these before paying out earnings to shareholders
What does Residual dividend policy assume?
- There is no taxation
- There are no transaction costs
- Information is perfect
(Perfect market)
What are the three main reasons for dividend relevance?
- Dividend signalling
- Clientele effect
- Preference for cash income
Give an example of dividend signalling?
Dividend is reduced and people think that something has gone wrong!
Give an example of Clientele effect?
Changes in dividend policy may upset shareholders e.g. for tax planning purposes
Explain Preference for cash income?
Many investors prefer cash today as opposed to potential rewards in the long term!
What are the main practical influences on a company when it sets a dividend?
▪ Does the company have sufficient distributable reserves to pay a dividend?
▪ Can a company legally pay a dividend?
▪ Is there sufficient cash to pay the dividend?
Give two Dividend Alternatives
▪ Scrip Dividends (Take dividend as shares)
▪ Share repurchase
Give an example of Scrip Dividends
This is when a company offers bonus shares free of charge as an alternative to a dividend.
Give an example of Share repurchase
Instead of a paying a dividend, shares are bought back by the company from the shareholders.
